undressing groupon

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Copyright © 2010 Ahmadali Arabshahi 1 UNDRESSING GROUPON An Analysis of the Groupon Business Model Ahmadali Arabshahi December 16, 2010 Introduction Groupon is fascinating. How can a two‐year old startup employing simple technologies (e.g. email and a website) generate hundreds of millions of dollars in economic value? Where is the value coming from? In this essay, I try to provide an answer and uncover the business model’s underlying principles. I find, and think that you will agree, that the model has many subtle intricacies. From a simple perspective, Groupon is a mediation platform that connects people seeking bargains with merchants who are willing to provide them. From another perspective, it is an online couponing system. But neither description does the model justice. A better way to gain insight is to think of Groupon as a monetization strategy. The company has a very large number of email subscribers and has figured out how to monetize them in a self‐reinforcing virtuous cycle. They do it by providing something of value to merchants. Our analysis begins by examining this something of value. Before that, we take a quick look at the subscribers: The Subscriber Base Groupon’s massive subscribers base – 40 million according to news reports – is an email distribution list segmented on the basis of geographical boundaries and a key factor in the company’s ability to mobilize customers. Email is both the mechanism for reaching subscribers and the basis of the connection’s persistence. But more importantly, it is cheap – something that can be appreciated by contrasting it with the practices of advertising in newspapers or slipping flyers under doors. With traditional methods, marginal costs increase with greater geographic coverage. But with email, the cost of sending a promotion is the same regardless of location. Because of this property, Groupon can target the maximum relevant geographic area when promoting a local merchant. Each deal region – usually a densely populated urban best described as an “expanded local” – is large enough to cover any subscriber with the potential to participate. The harvesting of the maximum geographic area maximizes Groupon’s ability to generate customers for merchants.

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  • Copyright2010AhmadaliArabshahi 1

    UNDRESSINGGROUPONAnAnalysisoftheGrouponBusinessModelAhmadaliArabshahiDecember16,2010

    IntroductionGrouponisfascinating.Howcanatwoyearoldstartupemployingsimpletechnologies(e.g.emailandawebsite)generatehundredsofmillionsofdollarsineconomicvalue?Whereisthevaluecomingfrom?Inthisessay,Itrytoprovideanansweranduncoverthebusinessmodelsunderlyingprinciples.Ifind,andthinkthatyouwillagree,thatthemodelhasmanysubtleintricacies.Fromasimpleperspective,Grouponisamediationplatformthatconnectspeopleseekingbargainswithmerchantswhoarewillingtoprovidethem.Fromanotherperspective,itisanonlinecouponingsystem.Butneitherdescriptiondoesthemodeljustice.AbetterwaytogaininsightistothinkofGrouponasamonetizationstrategy.Thecompanyhasaverylargenumberofemailsubscribersandhasfiguredouthowtomonetizetheminaselfreinforcingvirtuouscycle.Theydoitbyprovidingsomethingofvaluetomerchants.Ouranalysisbeginsbyexaminingthissomethingofvalue.Beforethat,wetakeaquicklookatthesubscribers:TheSubscriberBaseGrouponsmassivesubscribersbase40millionaccordingtonewsreportsisanemaildistributionlistsegmentedonthebasisofgeographicalboundariesandakeyfactorinthecompanysabilitytomobilizecustomers.Emailisboththemechanismforreachingsubscribersandthebasisoftheconnectionspersistence.Butmoreimportantly,itischeapsomethingthatcanbeappreciatedbycontrastingitwiththepracticesofadvertisinginnewspapersorslippingflyersunderdoors.Withtraditionalmethods,marginalcostsincreasewithgreatergeographiccoverage.Butwithemail,thecostofsendingapromotionisthesameregardlessoflocation.Becauseofthisproperty,Grouponcantargetthemaximumrelevantgeographicareawhenpromotingalocalmerchant.Eachdealregionusuallyadenselypopulatedurbanbestdescribedasanexpandedlocalislargeenoughtocoveranysubscriberwiththepotentialtoparticipate.TheharvestingofthemaximumgeographicareamaximizesGrouponsabilitytogeneratecustomersformerchants.

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    ValuetoMerchantsMerchantsbenefitfromaGroupontransactionmostobviouslybecauseofalargeinfluxofcustomersoverashortperiodoftime.Inthelongterm,amerchantcanalsobenefitfromrepeatcustomersandreferrals.Weassumerationalmanagers,soaGroupontransactionpresumablyleadstogreaterimmediateprofit,greaterfutureprofit,orboth(i.e.notsacrificingonefortheother).Inanutshell,Groupondeliverscustomersusingacombinationofapromotionalservice,apricediscriminationserviceandasupportingprepaymentservice.Whatisspecialisthemassivescaleofthebusinessbyvirtueofthelargesubscriberbase,theexpandedlocalsizeofeachregion,andthenumerousmarkets,bothdomesticandinternational.APromotionalServiceApromotionalserviceisanintegralpartofeveryGroupondealintheformofamarketingmessageembeddedinthedealemail.Thecreativeoftenfunnymessagesarepreparedbyexpertwritersandhighlighttheattributesoftheproductorservice.Theproximategoalofthemessagesistodrumupexcitementforthedealandcoaxsubscriberstopullthebuyingtrigger.Itistrialinducementweareprovidingthissuperdiscounttogetyoutotrytheproduct.Butitisalsoanadvertisingmessagethatraisesawarenessofthemerchantoveragreaterexpandedlocalregion.APrepaymentServiceGrouponcollectspaymentforservicesprovidedinthefutureandpaysmerchantsinadvance.Theserviceislikeaprepaidgiftcardandbenefitsmerchantsbecauseofthetimevalueofmoney.Cashnowisbetterthancashlater.AmerchantcantheoreticallybootstrapitselfbydoingaGrouponandusingthecashtostartorexpandoperations.Prepaymentalsobenefitsmerchantsbecauseofnonredemptions.Thelastcomponentofvalueisthemostsignificant:AnEngineforPriceDiscriminationGrouponscorebusinessispricediscriminationfornow,afancywordfordiscounteddeals.ThefuelofGrouponsabilitytodelivercustomersisthemassivescaleofthesubscribersandthenotionoftheharvestingofthemaximumgeographicregiontheexpandedlocalcoveringallpotentialcustomers.Thesparkisthemaximizationofdealacceptance.

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    Grouponspromotionaleffortsareobviouslyimportantinconvincingsubscriberstobuy.Butultimately,mostsubscriberspullthetriggerbecauseofasuperdiscountedprice.PricediscriminationisthereforethesecondkeyfactorinGrouponsabilitytogeneratecustomers.Firstaquickandsimplifiedoverviewofthemicroeconomictheory:Inatypicalmarketwithoneprice,amerchantcanincreasecustomerdemandbyloweringprice.Butthebenefitcomesatacosttheoriginalcustomerswhowerewillingtobuyattheoriginalpricealsoreceivethelowerpriceandconsequentlyprovidelessrevenueasagroup.Theanswer:pricediscriminationthepracticeofdistinguishingandseparatingpotentialcustomersonthebasisofpricesensitivityandofferingadifferentpricetoeachgroup.Therevenuefromtheoriginalcustomersisprotectedbycontinuingtoshowthemtheoriginalprice,whileadditionalrevenueisgeneratedfromnewpricesensitivecustomerswhowouldotherwisestayawaybecauseofthetargetedlowerprice.Themerchantgainsaslongasthelowerpriceishigherthanthemarginalcostofproducingtheirproductorservice.Thechallengeliesinidentifyingpricesensitivepotentialcustomers,commonlyaddressedintwoways:In3rddegreepricediscrimination,anobservablecharacteristicisusedasaproxyforthepricesensitivityofacustomer.Theobservablecharacteristicformsthebasisofsegmentationanddefinesacoherentgroupfortargeting.Oneexampleisthepracticeofofferingstudentdiscounts.Studentsarepresumablynonemployedandconsequentlymorepricesensitiveasaresultofthefinancialconstraint.In2nddegreepricediscrimination,customersarecategorizedbasedonactionsthatrevealtheirpricesensitivity,usedwhenobservablecharacteristicsarelackingorimpracticalasabasisforsegmentation.Customersaretypicallyluredintosignalingtheirpricesensitivitybasedontheirresponsetoasetofchoicescraftedbythebusiness.Couponsareawellknownexampleasuserswhogotothetroubleofcollectingthemaretakinganactionthatsignalstheirpricesensitivity.A3rdDegreePriceDiscriminationServicetoMerchantsTheprimaryGrouponservicetomerchantsisa3rddegreepricediscriminationservice.Fromtheperspectiveofmerchants,Grouponsubscribersareareadilyidentifiablegroup.TheobservablecharacteristicisthattheyareGrouponsubscribers.Theserviceprovidesawaytotargetthemarketsegmentdirectlywithapromotionalmessageandoffer.Allamerchanthastodoistosignacontractfortheservice.Itcanbetemptingtothinkoftheserviceasblockpricingaformof2nddegreepricediscriminationbecauseofthedealactivationthresholdrequirementofaminimumnumberofcustomers.Blockpricing,however,isdesignedtoidentifypricesensitivityattheindividuallevelbypresentingpotentialcustomerswithaquantitybasedchoice.WithGroupon,thejobofidentifyingpricesensitivecustomersisalreadydone.Furthermore,thegroupistargetedwithasingleprice,notaselectiondesignedtoelucidatepricesensitivity.

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    Onewaytoappreciatetheserviceistocontrastitwithanalternative.AcomparablemethodwouldhavetoincludeadvertisingonagrandscaleperhapsahalfpageadvertisementintheNewYorkTimes.Andtheadvertisementwouldhavetoincludeapricediscriminationcouponingmechanismtofilterconsumersbasedontheinconvenienceofclippingthem.CanyouimaginecouponsintheNYT?Itwouldlookterriblyoddeveniftheeditorsweretoallowit!TwoTiersof2ndDegreePriceDiscriminationGrouponprovidesmerchantswithaccesstoauniquetargetablemarketsegmentofpricesensitiveconsumers.ButhowdoesGrouponidentifypricesensitivityattheindividuallevelinordertobuildthegroupinthefirstplace?Asdiscussedpreviously,2nddegreepricediscriminationisthemethodofidentifyingpricesensitivecustomersonthebasisoftheirchoicesoractions.WhenaconsumersubscribestoGroupon,theyareessentiallymakingachoicethatsignalstheirpricesensitivity.Iftheprocesswereaconversation,itwouldlooklikethis:Groupon:Hey,Ihavesuperduperdeals,butyoumustgivemeyourname.Consumer:Ohyeah!PutmedownbecauseImpricesensitive.Grouponisthereforeaselfselectionmechanismforpricesensitiveconsumerstorevealthemselves.Pricesensitiveconsumerscannotresistthebaititiscatnipforthem.Subscribersprovidetheiremailaddress,whichconvenientlyservesasapipelineforcontinuedmessages.Butthereismore.Thereisalsoasecondtierof2ndDegreePriceDiscrimination!Whensubscribersarepresentedwithadeal,therearestringsattached.First,subscribersmustprepay.Grouponprovidestheplatformtodoso.Secondly,theymustagreetobeboundbythelimitationsofthedeal(e.g.admissionafter7pmonly).Lastly,subscribersmusttakeactionwithintheonedaylimitofthedealoffering.Incombination,theactionsareasetofchoicesthatconstituteanothertierof2nddegreepricediscrimination.Subscribersaresignalingtheirpricesensitivitybyagreeingtothehurdlesplacedinfrontofthem.Sointotality,Grouponisahighlyeffectivetwotier2nddegreepricediscriminationmechanismthatfilterssubscribersinawaythatcrediblydemonstratesapricesensitivegroup.PriceDiscriminationDegreeTransformation/ArbitrageWecannowbegintoappreciatethebeautyoftheGrouponbusinessmodel.Onthemerchantside,Grouponprovidesaconvenient3rddegreepricediscriminationserviceintheformofacoherenttargetablemarketsegment.Onthesubscriberside,Grouponidentifiespricesensitiveconsumerswithatwotier2nddegreepricediscriminationmechanismcomprisedofaselfselectionfilterandasetofhurdlesconsistingofprepayment,acceptanceoflimitations,andrequiredactionwithinthetimelimit.AndGrouponsitsinthemiddle.Thebusinessmodeltransformsthemorepowerfulbutdifficultmethodof2nddegreepricediscriminationtoamoreconvenientandpalatable3rddegreepricediscriminationservice.The

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    arrangementisessentiallyanarbitrageplatform.Intheprocess,Grouponextractsapremium.Onewaytovisualizeitisfromtheperspectiveofthefinancialflow.Grouponsellsaproductoraservicetoindividualconsumersatadiscountedpricebuttheneffectivelybuysitfromamerchantatanevenlowerprice.ThedifferenceisrevenuetoGroupon.ThenotionofarbitragestemsfromthefactthatGrouponrisksnothingintermsofhavingtoaccumulateinventoryorassumeanyobligations.Conventionalwisdomstatesthatarbitrageshouldnotpersistinthelongterm.TheincreaseincompetitionfromGrouponclonesmakescompletesensewhenseeninthislight.Grouponsmarginsthearbitragespreadwilllikelyerodeovertime.

    ImportantFunctionsTherearesomesubtletiesintheGrouponbusinessmodelthatmightnotappreciatedbyimitators.Anumberofimportantproblemsmustbeaddressed.Whetherbyaccidentordesign,theGrouponbusinessmodeladdressesthem.TheQualitySignalingProblemBusinessesfaceafundamentalproblemindiscounting.Alowerpricecanbeinterpretedasasignalofinferiorquality.Priceandqualityaretwosidesofthesamecoinandreflecteachother.Ifthereisamismatch,consumerscanbecomesuspicious.Itstheoldadageofifthepriceistoogoodtobetrue,thenitprobablyis.Becauseofthis,merchantsmustprovideanassuranceofqualitywhenrunningadiscountprogram.Grouponservesanessentialfunctionbyprovidinganassuranceofqualityfortheirdeals.Themarketingmessagestatesitexplicitly,talkingabouttopratedlocalsdealsandthebestlocalbusinesses.Customersmustbepersuadedthatadealpriceislowbecauseoftheexclusivityoftheofferingratherthanbecauseofaproblemwiththeproduct.Thisisaccomplishedinseveralinterestingways:

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    ThePromotionalMessageThepromotionalmessagesindealemailsprovideassurancesofqualitybyhighlightingtheattributesoftheproductorservice.Butbeyondthat,amoresubtleconfirmationbiasreinforcesthequality.AnaturalinterpretationofaGroupondiscountisthatamerchantbelievessostronglyinthequalityoftheirproductthattheyareprovidingadeepdiscounttoencouragepeopletotryit,confidentinthebeliefthatbuyerswillbecomerepeatcustomers.Byframingthepromotionalmessageinawaythatconfirmsthisviewpoint,Grouponcantakeadvantageofpeoplesnaturalsusceptibilitytoconfirmationbiastovalidatetheinterpretationandtoreinforcethepremiseofproductquality. TheDealActivationThresholdGrouponclaimsthatthedealactivationthresholdisvaluabletomerchantssinceitguaranteesaminimumnumberofcustomers.Theclaimsoundsplausibleandisintegratedintothedealbuyingexperienceasthenumberofcustomersiscounteddown.Butintruth,theguaranteeofaminimumnumberofcustomersisnotreallyvaluabletomerchants.Withmostdeals,justificationofthediscountedpricerequiresfarfewercustomers.Infact,assumingrationalpricing(i.e.Price>MC),amerchantshouldbewillingtoacceptanynumberofadditionalcustomers.Soeventhoughmerchantsvaluelargenumbersofadditionalcustomers,thereisnogoodreasontovaluetheguaranteeofalargenumberofcustomers.ThenwhydoesGrouponpromotetheclaimsoprominently?Theansweristhattheclaimreassurescustomersbypreemptivelyaddressingthequestionwhatisthemerchantreceivinginreturnforaspecialdiscount?ByprovidingafalseexplanationthatthemerchantisprovidingaspecialdealinexchangeforaguaranteeofaminimumnumberofcustomersGrouponstrengthensthepremiseofthespecialnessofthedealanddisplacespotentialdoubtsastothequality. AOneDayLimitontheAvailabilityofEachDealandLimitedMerchantExposureAcontinuousorconstantlyrecurrentdiscountprogramcansendanegativesignaltopotentialcustomers.Itsuggeststhatthediscountpriceisnotspecial.Perhapstheproductqualityislowandthemerchanthasbeenforcedtodiscountinordertosellit.Toavoidtheproblem,thedurationandfrequencyofdiscountprogramsmustbelimitedinthesamewayasonedayonlysalesintherealworld.Butthereisacostinthatthelimitationalsolimitstheextracustomersfromalongerdiscountprogram.Grouponprovidesasolutionbecauseofitsabilitytogenerateamassivenumberofcustomersfromasingledaypromotion.Amerchantcanreceivethesamenumberofcustomersinonedayaswithperhapsacontinuousmonthlongdiscountprogram.Andthemerchantavoidsthenegativesignalingpitfallsofoverexposurefromalongdurationdiscountingcampaign.

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    Asanaside,thenatureofthemerchantdetermineshowwellitcancopewiththeadditionalcustomers;therearethreecategories.Thefirstarebusinessesthatcanscaletoaccommodatethemassiveinfluxofcustomersonanimmediatebasis.Afitnessclubwithhugesurpluscapacityisanexample.TheybenefitfromaGroupontransaction.Thesecondarebusinessesthatcannotscalebutareexpectedtoprovideservicenontheless.Asmallcupcakeshopwithlimitedsurplusproductioncapacityandcustomerexpectationofondemandsatisfactionisanexample.TheymightnotbenefitfromaGroupontransactionandinfactmightsuffer.Andthelastarebusinessesthatcannotscaleandarenotexpectedtoprovideondemandservice.Massagetherapistsorotherbusinessesthatrequireappointmentsareexamples.TheybenefitthemostfromaGroupontransaction.Sincethereisnoexpectationofondemandservice,theadditionalcustomersaretimeshiftedviaanappointmentmechanismforexampleandservicedoveralongerduration.TheCredibilityProblemWouldyoutrustacarpetdealershipthathasbeenadvertisingagoingoutofbusinesssaleforoverayear?Sinceadiscountmeansnothingwhenappliedtoaninflatedprice,merchantsfaceacredibilitychallengeandmustassurepotentialcustomersoftheauthenticityoftheirdiscounts.Asanindependentthirdparty,Grouponservesanessentialfunctionbyprovidinganassuranceofdealvalue.Subscribersmustbeconvincedthatthedealsarevaluableandauthentic.ThefirstwayGroupondoesthisisbyensuringthatthedealsareinfactvaluable.Thisisprobablythereasonthedealsareoftensoextremefollowingtheoldsovietadageofwhenindoubt,addmoresteelormorelike,whenitdoubt,shaveanother10%.Theotherwayistomanageperceptions.Intheirmarketing,Groupontalksabouthugediscountsandincrediblylowprices.Butbeyondjustsayingit,theymustensurethatalltheiractivitiesarecongruentwithamessageofdealvalueandauthenticity.Severalelementsstandout: ASingleDealEachDayGrouponrunsasingledealadayineachcity.Whynotseveral?BecauseGrouponneedstopromoteanauraofexclusivityforeachdeal.Theimplicitmessageisthatthedealsaresorareandspecialthattherecanonlybeoneaday.Thisseeminglyinnocuousdetailgovernsthescalingstrategyofthebusinessmodel.Thelimitationofasingledealadaylimitstherevenuepotentialfromeachcity.Sotoscalerevenues,Grouponmustexpandgeographically. TheMythoftheCollectiveBuyingPowerTheGrouponmarketingmessagetalksaboutcollectivebuyingpower.Thecompanyclaimstonegotiateasuperpriceonbehalfoftheirsubscribers.Itmakessubscribersfeelwarmandfuzzyandreinforcesthemessagethatthepriceisspecialbyprovidingaplausiblereasonforit.

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    Butinreality,thecollectivebuyingpowerdoesnotbelongtosubscribers.ItactuallybelongstoGroupon.Powerimplieschoice,andGroupongetstochoosethemerchants.Grouponalsonegotiatesaverysignificantmarginforitselfbyleveragingthecollectivebuyingpower.AcarefulexaminationshowsthatGrouponsinterestsarenotperfectlyalignedwiththatoftheirsubscribers.Whilesubscribersbenefitfromthelowestpricepossible,Grouponhasanincentiveforahigherpricebecauserevenueisapercentageofthetransactionamount.TheconflictofinterestmustbemanagedtoavoidanydamagetoGrouponscredibility. TheGrouponPromiseTheGrouponpromiseisessentiallyaguaranteeofsatisfaction.Thecompanyprovidesarefundoutofitsownpocketifacustomerisnotsatisfied.Theguaranteeisafantasticwaytoreassurecustomersandcostsverylittleinpractice,especiallyinrelationtomargins.TheCustomerQualityProblemOneoftheproblemswithdiscountingisthatitcanattractlowerqualitycustomers.Thetermlowerqualitycustomerisnotmeanttobepejorative.Socialhierarchyisafactoflifeandmerchantsarenaturallysensitivetothekindofclienteletheyattract.Becauseofthecorrelationbetweenincomeandsocialclass,priceisoftenusedasamechanismtoenforcestandards.Thiscreatesaproblemforpricediscrimination.Consideranupscalerestaurant.Supposethattherestauranthasexcesscapacityandwantstoincreasecustomers.Nowimagineifthemerchantindiscriminatelyofferscouponswithsteepdiscounts.Thereisagoodpossibilitythattherestaurantwillattractundesirablecustomerswhowillalienatetheirexistingfullpriceclientele.Grouponprovidesasolutiontothecustomerqualityproblem,albeitincidentallyperhaps.ThedemographicsoftheGrouponsubscriberbasearehighlyfavorable.Aconsumermustpossesssomedegreeofcomputerliteracyinordertosubscribe,somethingthatcorrelatesstronglywitheducation,socialclass,anddiscretionaryincome.EventhoughGrouponsubscribersarepricesensitive,theyarenotpriceconstrained.Subscribersaretypicallyeducated,young,urbanprofessionals.Mostmerchantsaremorethanhappytocatertothem.TheSegmentationProblemTwoconditionsarenecessaryforsuccessfulpricediscrimination.Apricesensitivemarketsegmentmustbeidentified.Butimportantly,thesegmentmustbeisolatedfromtheexistingcustomerbase.Amerchantmustpreventexistingfullpricepayingcustomersfromtakingadvantageofthelowerdealpriceasituationthatlowersrevenueanddefeatsthepurposeofpricediscrimination.Grouponmeetsthischallengeintwoways.First,dealofferingsarenotpublicknowledge.TheyaretargetedemailstoGrouponsubscribersonly.RegularcustomersareexcludedunlesstheyalsohappentobeGrouponsubscribers,whichisunlikelybecauseofthesecondreason:aminimaloverlapbetweenGrouponssubscribersandmerchantsregularcustomersbecauseofanaturalseparationbasedonpricesensitivityandgeography.Grouponsubscribersareprice

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    sensitiveanddrawnfromalargerexpandedlocalregionalarea.Incontrast,merchantsregularcustomersaremostlypriceinsensitivebecauseofthehigherendnatureofmostmerchantsanddrawnfromthelocalvicinity.TheBigPictureGrouponisasolutiontoahithertounderappreciatedproblem.Qualitymerchantswanttopricediscriminatetoincreaseprofits.Likewise,qualitypricesensitiveconsumerswanttoconsumemoregoodsandservices.Grouponprovidesaplatformtomediatebetweenthetwogroupsandtoincreasetheutilityofboth.Thebusinessmodelisaconstructwhereinformation,incentives,signals,andotherfactorsareallalignedinsuchawayastoachieveabetterequilibrium.AVirtuousGrowthCycleWhenasystemexhibitsexplosivegrowth,apositivefeedbackloopisofteninvolved.Grouponowesitsrapidgrowthtoaselfreinforcingvirtuouscycle:Theprocessisasfollows: TheGrouponbrandsignals:

    o Anassuranceofqualityo Anassuranceofdealvalueo Anexcitingwaytodiscovernewexperiences

    Themessageresultsinsubscribergrowth

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    Becauseofthesubscribergrowth,Grouponsabilitytodelivercustomersisenhanced Asaresult,thereisgreatermerchantdemandforGroupon Becauseofthegreatermerchantdemand,Groupongainsleveragein:

    o Choosinghigherqualitymerchantso Negotiatinghigherdiscounts

    ThehigherqualityanddeeperdiscountsreinforcetheGrouponbrandandreputation ThecyclerepeatsResourcesGrouponhasbeengrowingrapidlyandmaintainingsuperhighmarginsdespitearidiculousnumberofcompetitors.Sowhatgivesthemanedge?Certainly,beingthefirstoutofthegatehasbeenanadvantage.Butwhatisthemanifestationoftheadvantage?Thekeyresourcesbecomeapparentbylookingatthevirtuousgrowthcycle. TheSubscriberBaseGrouponssubscriberbaseislargerthanallitscompetitorsandadistinctcompetitiveadvantage.Asseeninthevirtuouscyclediagram,thesubscriberbaseiscentraltoGrouponsabilitytodelivercustomers.Thevalueofthesubscriberbasecriticallydependsonthepermissionforcontinuedmessages,whichisimplicitlygrantedwhenasubscribersignsup.Theprivilegeofintrudingonapersonsconsciousnessisveryvaluable.Butitisalsoveryfragile.Grouponmustbecarefulnottoabusetheprivilegeascustomerscaneasilyunsubscribe(i.e.Grouponicusemails).HowhasGrouponmanagedtoaccumulatesomanysubscribers?Theansweristhenextkeyresource. BrandandReputationGrouponsmostimportantresourceisitsbrandandreputation.Asseeninthevirtuouscyclediagram,subscribergrowth,whichiscriticalforthesuccessofGrouponbusinessmodel,reliesonassurancesofqualityandcredibility.SubscribersmustbelieveGroupon.Bymanagingsignals,stayingcongruent,anddoingtherightthingsconsistently,Grouponhasaccumulatedbrandequityandcanthereforemakesassurancesasatrustedindependentthirdparty.TheGrouponbrandalsoattractssubscribersbecauseofitsassociationwithdiscoveringfunactivitiesinyourcityandfindingcoolnewexperiencesasdescribedbytheGrouponmarketingmessages.WhoknewyoucouldgetaBrazilianwaxwhiletakingaboattourofNYC?Thefeelingofcoolnessisareflectionofthecultureofthecompanyandcannotbeimitatedeasily,embodiedineverythingfromthewittypromotionalmessagestothefreshcolorschemeofthewebsite. MerchantRelationshipsandExpertise

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    Grouponhasinvestedheavilyinsalesandcustomerservicecapabilities.Thefunctionsgeneraterevenuedirectlyandarethereforeveryimportant.Theaccumulationofknowledge,experienceandrelationshipswithmerchantscanbeconsideredaresource. OperationsandExecutionExpertiseThegrowthofGrouponhasbeenphenomenal.Scalingabusinesssoquicklyisnojoke.Itdemonstratesoperationalchopsandmanagementprowess.Butdoesitdemonstrateanabilitytoinnovate?ItcanbearguedthatGrouponstumbledontoitsbusinessmodel.Soperhapsthejuryisstilloutonthequestion.TheCompetitivePictureGrouponfacestwodistinctcompetitivethreats.Thefirstisfrombusinesseswithsimilarbusinessmodels.Therearehundredsofthem,buttheimpacthasbeenminimal.Marginswillprobablysufferinthefuture,buttheyaresohighthatitwilltakealongtimeforanyseriousproblemstoemerge.AfactorinGrouponsfavoristhatthemarketisstillgrowingandfarbeingsaturated.AnotheristhatGrouponsmassivescaleprovidesahugeadvantageintheirabilitytodelivercustomersandwillprotectmarketshareinamorecompetitiveenvironment.Forthetimebeing,Groupondoesnothavetoworryaboutimitators.Therealthreatisfromtheemergenceofasuperiorbusinessmodel.LetusrevisitthefundamentalproblemsolvedbyGroupontheneedtomediatebetweenmerchantswhowishtopricediscriminateandpricesensitiveconsumers.Grouponsbusinessmodelisaversion1.0solutionthereisalotofroomforimprovement.Oneproblemisthemodelchannelsaninordinatenumberofcustomerstoasinglemerchant(sometimestoomany)attheexclusionofallothers.Anotheristhatitisveryexpensive,extractingofaheavy50%shareoftherevenueironicsinceGrouponisinthebusinessofprovidingapricediscriminationservice.Asuperiormodelwouldbemorepluralandlessonerousintermsofprice.Orstateddifferently,itwouldproducehigherquantitiesoftheserviceatalowerprice.Whatwouldsuchamodellooklike?First,alittlegroundwork:TheEquivalenceofAdvertisingandPriceDiscriminationProductandpricearetwosidesofthesamecoin.Theworthofaproducttoaconsumeritsutilityissubjectiveanddependsonhowmuchaconsumerdesirestheproduct.Price,ontheotherhand,isanobjectivemeasurethecostoftheproductintherealworld.

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    Thetwoareintimatelyconnectedinthattheybothdeterminethevalueofaproductthespreadbetweenthesubjectiveworthofaproductandtherealworldprice.Valueincreasesnotonlywhenaproductisdesiredmorebutalsowhenthepriceislowered.Considerasilvernecklaceatabargainpriceoftendollars.Itisactuallymorevaluablethananidenticalgoldoneatamilliondollars.Inthesameway,advertisingandpricediscriminationareintimatelyconnected.Bothhaveanequivalentobjective:increasingaconsumersperceptionofvalue.Advertisingdoesitbyraisingaconsumerssubjectiveperceptionoftheutilityoftheproduct.Pricediscriminationdoesitbyloweringtheprice.Onethingtonote:pricediscriminationismuchtrickier.Unlikeadvertisingwhichmovesthevalueneedleinonlyonedirection(unlessamarketerreallyscrewsup)pricediscriminationcaneasilylowervalueifdoneincorrectly.Becauseofthecomplexitiesofsignaling,alowerpricecanperverselylowerthesubjectiveworthoftheproduct.Superluxurygoodswherepricesarecompletelydisconnectedfromtheinherentworthoftheproductsaregoodexamplesinthatcustomersactuallyseekahighpriceinordertosignalwealth.TheGoogleTheequivalenceofadvertisingandpricediscriminationmeansthatGoogleandGrouponareessentiallyinthesamebusinessasurprisingrealizationsincethebusinessmodelsaresodifferent.BothcompaniesprovideaservicetoinfluenceconsumersperceptionofproductvalueGoogleviaadvertisingandGrouponviapricediscrimination.Andbothaimtodelivercustomersonevirtually,theotherinthephysicalworld.Itbegsthequestion:canGooglecompetewithGroupon?Ifso,how?Theshortansweristhattheycan.Moreover,theycandoitwellbecausetheypossessallthenecessarytoolsandresourcestoinnovateandcreateasuperiorbusinessmodel.Twopotentialscenariosarepresentedhere.ThefirstisanevolvedversionoftheGrouponbusinessmodel.ThesecondisamoreprofoundintegrationofpricediscriminationintotheexistingGoogleAdsenseandAdwordsplatforms. AnextgenerationbusinessmodelTheGrouponpricediscriminationdegreetransformationmodelhastwosidesthemerchantfacingsideandsubscriberfacingside.Themerchantfacingsideistherealworldandinvolvesthemerchantsalesandservicefunctions.Thesubscriberfacingsideisdataorientedandinvolvesthefundamentaltaskofidentifyingpricesensitivity.Onthedatasideoftheequation,Grouponstwotier2nddegreepricediscriminationfunctionisarelativelycrudewayofidentifyingpricesensitivity,relyingonselfselectionandseveralhurdles.Itworksinabinarywayandcannotmeasurethemagnitudeofpricesensitivity.

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    Google,ontheotherhand,hasaccesstovastamountsofdata,includingGmailuserdata,searchqueries,clickthroughdata,andallmannerofotherinformationfromtheirvastconstellationofservices.Ontopofthat,theyareexpertsatcomputationalalgorithms.Theycaneasilyimplementsophisticatedanalysistoidentifypricesensitiveusersandtomeasurethemagnitudeofthepricesensitivityasaquotientassignedtoeachuser.Forexample,ifauserfrequentswebsiteswithinformationonhowtosavemoneythenGooglewouldknowthattheuserispricesensitive.ButifaGmailuserreceivesareservationconfirmationemailfromaveryexpensiverestaurantthenGooglewouldconcludethattheuserispriceinsensitive.TheGooglesystemwouldbemuchclosertotheidealof1stdegreepricediscriminationandfarsuperiortoGrouponstwotier2nddegreepricediscriminationfunction.ItwouldgiveGoogleacompetitiveadvantageintheirabilitytotargetusersandtomaximizeprofitsformerchants.Allthatwouldremainistogrowasubscriberbase.Googlecoulddothatcheaplybyadvertisingonitsownplatforms.Moreeffectively,theycouldgetpermissionfromGmailuserstomessagethemeasilydonewithaprominentTurnondailylocaldealsbuttoninGmail.Amassivesubscriberbasewouldinstantlyspringtolife.Onthemerchantsideoftheequation,GooglecouldeasilyimitatetheGrouponmodel.TheypossessthefinancialresourcestobuildtheirownsalesandcustomerserviceorganizationinthesamewayasGroupon.Buttheyhaveamuchmorepowerfuloption:toexternalizethemerchantfacingsalesandservicefunctionstoindependentlocallybasedaffiliates.Theweprovidetheplatformonlymodelwouldbesuperiorfortworeasons:First,adistributedcollectionoflocalaffiliateswouldholdaninformationandrelationaladvantageoveracentralizedarmyofnonlocalsalesandserviceemployees(i.e.GrouponsChicagooffice).Nativefolkknowtheircommunitiesbetterandaremoreeffectiveincultivatingmerchantrelationshipsthanoutsiders.Secondly,anexternalizedmodelwouldhaveafinancialandscalabilityadvantage.Internalsalesandcustomersupportemployeesneedcareandfeedingandrequireahugeamountofworkingcapitaltosupporttheiroperations(lookatthefundingthatGrouponissoakingup).Anexternalizedmodelwouldbemorecapitalefficientandthereforemorescalable,absenttheinvestmentrequirementsofgrowingasalesandserviceorganization.ExternalindependentlocalaffiliatesproperlyincentivizedwithaprofitmotivewouldbefarmoreeffectiveandcostefficientincoveringthemanysmalllocalareasthatarecurrentlybeingignoredbytheGrouponmodel.Toillustratethis,imaginealocalnewspaperwitharestaurantreviewcolumn.TheycouldbecomeaGoogleaffiliateandbegintoofferadealadayforafeaturedrestaurant.Theywouldhandlethesales,customerservice,andpromotionalemaildesignallthefunctionsperformedbythemerchantfacingsideofGroupon.TheywouldthenusetheGoogleplatformtoofferadeal.Theplatformwouldtakecareofallthenecessarytechnologyfunctions,includingsendingemails,runningthewebsite,andpaymentprocessing.Andbecauseofloweroverhead,theaffiliatewouldshareintherevenueformuchlessthantheonerous50%Grouponfee.

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    ThishypotheticalGoogleplatformwouldrequireconsiderablethoughtanddesign.Alltheimportantissuesdiscussedinthispaperwouldhavetobeaddressed.Butitcouldbeagamechanger.Thereistremendousroomforinnovation.Onepossibilityistheintegrationofanauctionmodel,inthesamewayasthecurrentAdwordsprogram.ThirdpartyaffiliateswouldcompeteforaccesstotheGoogleplatform.Thecompetitivedynamicswouldensurethatonlythebestdealaffiliateswouldcontinuetothrive.

    TheintegrationofpricediscriminationintoAdwordsandAdsenseApotentiallymoreprofoundapplicationoftheprinciplesofpricediscriminationisintegrationintotheexistingflagshipGoogleAdwordsandAdsenseplatforms.TheentirebasisofGooglesadvertisingbusinessisrelevance.Advertisementsareprimarilytargetedonthebasisofsearchandcontextrelevanceaswellaslocation,languageandotherparameters.Asdescribedalready,Googlepossessestheresourcestoalgorithmicallyidentifypricesensitivityonanindividualbasis.ConsiderifthisparameterisaddedtoGooglesadvertisingplatformasatargetingoption.Inadditiontorelevance,advertiserswouldbeabletotailortheirmessagesbasedonthepricesensitivityoftheviewer.Apricesensitiveusermightbeshownanadvertisementthathighlightsadiscountwhereasapriceinsensitiveusermightbe

  • Copyright2010AhmadaliArabshahi 15

    targetedwithamessagethathighlightsthehighendfeaturesofaproduct.Theplatformcouldalsobeusedtodistributedailydealsbutwithevengreaterflexibility.IfGrouponspowerisderivedfromthescaleofitstargetaudience,onecanonlymarvelatthepossibilitieswithGoogleinthisscenario.CreditCardCompaniesPerhapsnootherbusinessisinabetterpositiontoidentifypricesensitivitythancreditcardcompanies.Offermatic,anewmarketentrant,usescreditcardtransactioninformationasthebasisofdistributingdailydeals.Butitappearsasthoughtheytargetdealsbasedonrelevance,whichwouldmeanthattheyarecompletelymissingthepoint.Unlessthedealsarecouponsforspecificproducts,thentheservicewillactuallyharmmerchants.Byignoringpricesensitivity,merchantsarechasingtheirowntailsinazerosumgameofstealingcustomersfromeachotherorworst,possiblycannibalizingtheirexistingfullpricepayingcustomerbase.Nonetheless,creditcardcompanieshaveaccesstodatathatcanyieldpricesensitivityquotientsforconsumers.Whethertheycanbuildabusinessmodelarounditisanothermatter.Thefirstchallengeisgettingpermissiontomessageusers.Perhapsitcanbedone,butconsumersaregenerallynotfavorablydisposedtowardcreditcardcompanies.BuildingaBetterModelWecouldplayagameofbuildthebusinessmodel.Ourgoalwouldbetoengineerabusinessmodelthatiscoolerandmoreefficientinconnectingpricediscriminatingvendorswithpricesensitiveconsumers.Thereisalotroomforcreativity.Conceptsandtoolssuchascrowdsourcing,openAPIs,notionsofdisintermediation,mobileplatforms,twitter,theFacebooksocialgraph,andahundredotherresourcescanbemeldedintoabetterplatform.Itjusttakesimagination.LookingtotheFutureIfyouthinkaboutit,thehumanconditionisveryinefficient.LetusconsiderourprivilegedexistenceastypicalAmericancitizens.AsIwasleavingmyapartmenttodaytodrivetothegrocerystoreonaverycoldday,aneighborwasleavingthebuildingonfoot,probablyheadedtothesubwaystation.Thesubwaystationisonthewaytothegrocerystoreanditwouldhavecostmenothingtogivethepersonalift.PerhapshewaswillingtopayseveraldollarsfortherideandperhapsIcouldhaveforwardedthepaymenttosomecharity.Ifonlytherewasaplatformtomakeitpossible.Thereasonformytriptothegrocerystorewastobuymilk.Unknowntome,anotherneighborwasthereatthesametime.Shecouldhaveeasilypickedupanothercartonofmilkanddroppeditoffatmyplace.Iwouldhavebeenmorethanhappytopayasmallfeefortheservice.And

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    perhapsshewouldhavebeenhappytodoit.Itsurewouldhavesavedsomegas.Ifonlytherewasaplatformtohelpmakeitpossible.AtthegrocerystoreIstartedwonderingwhathappenstofoodoncetheexpirationdatepasses.Googlegavemetheanswer.Itisthrownaway,eventhereallyexpensivefreshcrabmeat.Iwouldhaveboughtitifitwerejustabitcheaper.Ifonlytherewasaplatformtohelpmakeitpossible.Andthesewereobservationsfromjustonemorning.SowhattheheckdoesthishavetodowithGroupon?Withallthetalkofpricediscrimination,socialthis,andFacebookthat,itiseasytolosetrackofwhatisimportant.Onanabstractlevel,Grouponfunctionstopromoteamoreefficientusageofeconomicandhumancapacity.Thereisanincreaseinsocialwelfareasbothmerchantsandconsumersendupwithahigherutility.Thepricepointrightnowmightbealittlehigh,butthatisnormalfortheearlystagesofanyproductorservice.WhatGrouponhasdoneistodemonstratetheeconomicpotentialofleveragingsimpletechnologiestoaddressdeeplyembeddedinefficienciesinlife.Andtheeconomicpotentialishuge!AsGrouponlookstothefuture,itmustfinditspurposeinthegreaterhistoricalcontext.Willthecompanyselloutorwillitembraceagreatermission?Theyseemtobegoingforthelatter.Butdotheyhavetheinnovationchopstosucceed?TheopportunitiesaretheretocreatenextgenerationplatformstoleveragetechnologyandtheInternettomakelifebetterforall.